<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended November 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____to_____
Commission file number 0-16986
ACCLAIM ENTERTAINMENT, INC.
---------------------------
(Exact name of the registrant as specified in its charter)
DELAWARE 38-2698904
-------- ----------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
ONE ACCLAIM PLAZA, GLEN COVE, NEW YORK 11542
--------------------------------------------
(Address of principal executive offices)
(516) 656-5000
--------------
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
---
As at January 12, 1999, approximately 53,725,000 shares of Common Stock of the
Registrant were issued and outstanding.
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in 000s, except per share data)
<TABLE>
<CAPTION>
(Unaudited)
November 30, August 31,
1998 1998
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $58,023 $47,273
Accounts receivable - net 55,624 39,177
Inventories 7,554 3,430
Prepaid expenses 11,304 16,571
------ ------
TOTAL CURRENT ASSETS 132,505 106,451
------- -------
OTHER ASSETS
Fixed assets - net 29,653 29,294
Excess of cost over fair value of net assets acquired - net of
accumulated amortization of $19,856 and $19,218, respectively 23,402 21,433
Other assets 2,715 3,229
----- -----
TOTAL ASSETS $188,275 $160,407
-------- --------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
CURRENT LIABILITIES
Trade accounts payable $33,832 $24,218
Short-term borrowings --- 16
Accrued expenses 95,939 92,207
Income taxes payable 6,395 6,918
Current portion of long-term debt 724 724
Obligation under capital leases - current 1,345 1,468
----- -----
TOTAL CURRENT LIABILITIES 138,235 125,551
------- -------
LONG-TERM LIABILITIES
Long-term debt 51,500 51,931
Obligation under capital leases - noncurrent 1,085 1,110
Other long-term liabilities 2,907 3,588
----- -----
TOTAL LIABILITIES 193,727 182,180
------- -------
STOCKHOLDERS' DEFICIENCY
Preferred stock, $0.01 par value; 1,000 shares authorized; none issued -- --
Common stock, $0.02 par value; 100,000 shares authorized;
53,609 and 52,634 shares issued, respectively 1,072 1,053
Additional paid in capital 195,911 189,645
Accumulated deficit (198,893) (209,180)
Treasury stock, 523 shares (3,103) (3,103)
Foreign currency translation adjustment (439) (188)
----- -----
TOTAL STOCKHOLDERS' DEFICIENCY (5,452) (21,773)
------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY $188,275 $160,407
-------- --------
</TABLE>
See notes to consolidated financial statements.
1
<PAGE>
ACCLAIM ENTERTAINMENT, INC
AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED OPERATIONS
(in 000s, except per share data)
(Unaudited)
Three Months Ended
November 30,
1998 1997
---- ----
NET REVENUES $104,831 $92,277
COST OF REVENUES 50,500 44,002
------ ------
GROSS PROFIT 54,331 48,275
------ ------
OPERATING EXPENSES
Marketing and sales 17,519 17,098
General and administrative 14,930 14,081
Research and development 11,228 8,344
------ -----
TOTAL OPERATING EXPENSES 43,677 39,523
------ ------
EARNINGS FROM OPERATIONS 10,654 8,752
------ -----
OTHER INCOME (EXPENSE)
Interest income 795 460
Interest expense (1,407) (1,440)
Other income 758 344
--- ---
EARNINGS BEFORE INCOME TAXES 10,800 8,116
------ -----
PROVISION FOR INCOME TAXES 513 106
--- ---
NET EARNINGS BEFORE
MINORITY INTEREST 10,287 8,010
------ -----
MINORITY INTEREST --- (5)
----- ---
NET EARNINGS $10,287 $8,015
------- ------
BASIC EARNINGS PER SHARE $0.19 $0.16
----- -----
DILUTED EARNINGS PER SHARE $0.16 $0.15
----- -----
See notes to consolidated financial statements.
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' (DEFICIENCY) EQUITY
(in 000s, except per share data)
<TABLE>
<CAPTION>
Preferred Stock (1) Common Stock
------------------- -----------------
Issued Issued
------ ------
(Accumulated
Additional Deficit)
Paid-In Deferred Retained
Shares Amount Shares Amount Capital Compensation Earnings
------ ------ ------ ------ ------- ------------ --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance August 31, 1996 ---- ---- 50,041 $1,001 $180,895 $(15,113) $(70,642)
-------- -------- ------ ------ -------- --------- ---------
Net Loss ---- ---- ---- ---- ---- ---- (159,228)
Issuances and Cancellations
of Warrants and Options ---- ---- ---- ---- 722 566 ----
Deferred Compensation Expense ---- ---- ---- ---- ---- 6,134 ----
Exercise of Stock Options ---- ---- 81 1 169 ---- ----
Escrowed Shares Received ---- ---- ---- ---- ---- ---- ----
Foreign Currency Translation Gain ---- ---- ---- ---- ---- ---- ----
Unrealized Loss on
Marketable Equity Securities ---- ---- ---- ---- ---- ---- ----
-------- -------- -------- -------- -------- ----- ------------- -------------
Balance August 31, 1997 ---- ---- 50,122 1,002 181,786 (8,413) (229,870)
-------- -------- ------ ----- ------- ------- ---------
Net Earnings ---- ---- ---- ---- ---- ---- 20,690
Issuance of Common Stock for
Litigation Settlements ---- ---- 1,274 26 6,868 ---- ----
Issuances and Cancellations
of Common Stock and Options ---- ---- 15 1 239 690 ----
Deferred Compensation Expense ---- ---- ---- ---- ---- 4,190 ----
Exercise of Stock Options ---- ---- 1,223 24 4,285 ---- ----
Escrowed Shares Received ---- ---- ---- ---- ---- ---- ----
Foreign Currency Translation Gain ---- ---- ---- ---- ---- ---- ----
-------- -------- -------- -------- -------- --------- -------------
Balance August 31, 1998 ---- ---- 52,634 1,053 193,178 (3,533) (209,180)
-------- -------- ------ ----- ------- ------- ---------
Net Earnings ---- ---- ---- ---- ---- ---- 10,287
Issuances of Common Stock ---- ---- 206 4 1,792 ---- ----
Issuance of Warrants for
Litigation Settlement ---- ---- ---- ---- 950 ---- ----
Subordinated Notes Conversion ---- ---- 48 1 249 ---- ----
Issuances and Cancellations
of Common Stock and Options ---- ---- ---- ---- (362) 362 ----
Deferred Compensation Expense ---- ---- ---- ---- ---- 630 ----
Exercise of Stock Options
and Warrants ---- ---- 721 14 2,645 ---- ----
Foreign Currency Translation Gain ---- ---- ---- ---- ---- ---- ----
-------- -------- -------- -------- --------- -------- ---------
Balance November 30, 1998 ---- ---- 53,609 $1,072 $198,452 $(2,541) $(198,893)
---------- -------- ------ ------ -------- -------- ---------
<CAPTION>
Unrealized
Foreign Gain (Loss) On
Currency Marketable
Treasury Translation Equity
Stock Adjustment Securities Total
----- ---------- ---------- -----
<S> <C> <C> <C> <C>
Balance August 31, 1996 $(1,813) $(754) $15 $93,589
-------- ------ --- -------
Net Loss ---- ---- ---- (159,228)
Issuances and Cancellations
of Warrants and Options ---- ---- ---- 1,288
Deferred Compensation Expense ---- ---- ---- 6,134
Exercise of Stock Options ---- ---- ---- 170
Escrowed Shares Received (1,091) ---- ---- (1,091)
Foreign Currency Translation Gain ---- 107 ---- 107
Unrealized Loss on
Marketable Equity Securities ---- ---- (15) (15)
-------- -------- ---- ----
Balance August 31, 1997 (2,904) (647) 0 (59,046)
------- ----- - -------
Net Earnings ---- ---- ---- 20,690
Issuance of Common Stock for
Litigation Settlements ---- ---- ---- 6,894
Issuances and Cancellations
of Common Stock and Options ---- ---- ---- 930
Deferred Compensation Expense ---- ---- ---- 4,190
Exercise of Stock Options ---- ---- ---- 4,309
Escrowed Shares Received (199) ---- ---- (199)
Foreign Currency Translation Gain ---- 459 ---- 459
-------- --- ------ ---
Balance August 31, 1998 (3,103) (188) 0 (21,773)
------- ---- - -------
Net Earnings ---- ---- ---- 10,287
Issuances of Common Stock ---- ---- ---- 1,796
Issuance of Warrants for
Litigation Settlement ---- ---- ---- 950
Subordinated Notes Conversion ---- ---- ---- 250
Issuances and Cancellations
of Common Stock and Options ---- ---- ---- ----
Deferred Compensation Expense ---- ---- ---- 630
Exercise of Stock Options
and Warrants ---- ---- ---- 2,659
Foreign Currency Translation Gain ---- (251) ---- (251)
------- ----- ------- -------
Balance November 30, 1998 $(3,103) $(439) $0 $(5,452)
------- ----- -- -------
</TABLE>
(1) The Company is authorized to issue 1,000 shares of preferred stock at
a par value of $0.01 per share, none of which shares is presently
issued and outstanding.
See notes to consolidated financial statements.
3
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(in 000s, except per share data)
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
November 30,
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS PROVIDED BY (USED IN)
OPERATING ACTIVITIES
Net Earnings $10,287 $8,015
------- ------
Adjustments to reconcile net earnings to net cash (used in) provided by
operating activities:
Depreciation and amortization 2,763 3,449
Provision for returns and discounts 16,730 13,640
Minority interest in net earnings of consolidated subsidiary --- (5)
Deferred compensation expense 630 1,106
Non-cash royalty charges 136 221
Other non-cash items (22) 446
Change in assets and liabilities, net of effects of acquisition:
Accounts receivable (29,356) (32,366)
Inventories (4,048) 1,996
Prepaid expenses 5,205 7,421
Trade accounts payable 9,637 4,083
Accrued expenses 335 (3,608)
Income taxes payable (188) 99
Other long-term liabilities (681) 2,591
----- -----
Total adjustments 1,141 (927)
----- -----
NET CASH PROVIDED BY OPERATING ACTIVITIES 11,428 7,088
------ -----
CASH FLOWS PROVIDED BY (USED IN)
INVESTING ACTIVITIES
Acquisition of subsidiary, net of cash acquired (421) ---
Acquisition of fixed assets, excluding capital leases (1,868) (746)
Disposal of fixed assets 56 9
Disposal of other assets 43 ---
-- -----
NET CASH (USED IN) INVESTING ACTIVITIES (2,190) (737)
------- -----
</TABLE>
4
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(Continued)
(in 000s, except per share data)
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
November 30,
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS PROVIDED BY (USED IN)
FINANCING ACTIVITIES
Payment of mortgage $(181) $(348)
Payment of short-term bank loans (16) (618)
Exercise of stock options and warrants 2,659 62
Payment of obligation under capital leases (343) (283)
Miscellaneous financing activities -- 46
---- --
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,119 (1,141)
----- -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (607) (185)
----- -----
NET INCREASE IN CASH AND CASH EQUIVALENTS 10,750 5,025
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 47,273 26,254
------ ------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $58,023 $31,279
------- -------
Supplemental schedule of noncash investing and financing activities:
1998 1997
---- ----
Acquisition of equipment under capital leases $58 $---
Cash paid during the year for:
Interest $2,414 $1,849
Income taxes $624 $---
In fiscal 1999, the Company purchased certain assets and liabilities of a
distributor in Australia. In connection with the acquisition, liabilities
assumed were as follows:
Fair value of assets acquired $1,186
Excess of cost over fair value of net assets acquired 2,607
Cash paid, net of cash acquired (580)
Fair market value of common stock issued (1,796)
-------
Liabilities assumed $1,417
------
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in 000s, except per share data)
1. Interim Period Reporting - The data contained in these financial statements
are unaudited and are subject to year-end adjustments; however, in the opinion
of management, all known adjustments (which consist only of normal recurring
accruals) have been made to present fairly the consolidated operating results
for the unaudited periods.
2. Accounts Receivable
Accounts receivable are comprised of the following:
November 30, August 31,
1998 1998
---- ----
Receivables assigned to factor $78,400 $79,338
Advances from factor 28,872 34,914
------ ------
Due from factor 49,528 44,424
Unfactored accounts receivable 4,956 6,398
Foreign accounts receivable 36,648 22,201
Other receivables 1,852 3,414
Allowances for returns and discounts (37,360) (37,260)
-------- --------
$55,624 $39,177
------- -------
Pursuant to a factoring agreement, the Company's principal bank acts
as its factor for the majority of its North American receivables, which are
assigned on a pre-approved basis. At November 30, 1998, the factoring charge
amounted to 0.25% of the receivables assigned. The Company's obligations to
the bank are collateralized by all of the Company's and its North American
subsidiaries' accounts receivable, inventories and equipment. The advances for
factored receivables are made pursuant to a revolving credit and security
agreement, which expires on January 31, 2000. Pursuant to the terms of the
agreement, as amended, which can be canceled by either party upon 90-days
notice prior to the end of the term, the Company is required to maintain
specified levels of working capital and tangible net worth, among other
covenants. As of November 30, 1998, the Company was in compliance with the
covenants under its revolving credit facility.
The Company draws down working capital advances and opens letters of
credit (up to an aggregate maximum of $20 million) against the facility in
amounts determined on a formula based on factored receivables, inventory and
cost of imported goods under outstanding letters of credit. Interest is
charged at the bank's prime lending rate plus one percent per annum (8.75% at
November 30, 1998) on such advances.
Pursuant to the terms of certain distribution, warehouse and credit
and collection agreements, certain of the Company's foreign accounts
receivable are due from distributors. These receivables are not collateralized
and as a result management continually monitors the financial condition of
these distributors. No additional credit risk beyond amounts provided for
collection losses is believed inherent in the Company's accounts receivable.
At November 30, 1998 and August 31, 1998, the balance due from a distributor
was approximately 25% and 24%, respectively, of foreign accounts receivable.
6
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in 000s, except per share data)
3. Long-Term Debt
Long-term debt consists of the following:
November 30, August 31,
1998 1998
10% Convertible Subordinated Notes due 2002 $49,750 $50,000
Mortgage note 2,474 2,655
----- -----
52,224 52,655
Less: current portion 724 724
--- ---
$51,500 $51,931
------- -------
The 10% Convertible Subordinated Notes due 2002 (the "Notes") are
convertible into shares of common stock prior to maturity, unless previously
redeemed, at a conversion price of $5.18 per share, subject to adjustment
under certain conditions. The Notes are redeemable in whole or in part, at the
option of the Company (subject to the rights of holders of senior
indebtedness) at 104% of the principal balance at any time on or after March
1, 2000 through February 28, 2001 and at 102% of the principal balance
thereafter to maturity.
4. Earnings Per Share
Basic earnings per share is computed based upon the weighted average
number of common shares outstanding. Diluted earnings per share is computed
based upon the weighted average number of common shares outstanding increased
by dilutive common stock options and warrants and the effect of assuming the
conversion of the outstanding Notes, if dilutive. Prior year earnings per
share data has been restated to apply the provisions of SFAS 128. The table
below provides the components of the per share computations.
Three Months Ended
November 30,
1998 1997
---- ----
BASIC EPS COMPUTATION
Net earnings $10,287 $8,015
------- ------
Weighted average common shares outstanding 52,900 50,385
Basic earnings per share $0.19 $0.16
DILUTED EPS COMPUTATION
Net earnings $10,287 $8,015
10% Convertible Subordinated Notes Interest Expense 1,244 ---
----- ------
Adjusted Net Income $11,531 $8,015
------- ------
Weighted average common shares outstanding 52,900 50,385
Stock options and warrants 8,470 3,370
10% Convertible Subordinated Notes 9,605 ---
----- ------
Diluted common shares outstanding 70,975 53,755
------ ------
Diluted earnings per share $0.16 $0.15
5. Comprehensive Income
Effective September 1, 1998 the Company has adopted Statement of
Financial Accounting Standards No. 130 "Reporting Comprehensive Income" which
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in the financial
statements. The Company's total comprehensive earnings were as follows:
7
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in 000s, except per share data)
5. Comprehensive Income - (Continued)
Three Months Ended
November 30,
1998 1997
---- ----
Net earnings 10,287 8,015
Other comprehensive earnings (losses):
Foreign currency translation adjustments (251) 93
----- --
Comprehensive earnings $10,036 $8,108
------- ------
6. Acquisition
On November 12, 1998 the Company acquired substantially all of the
assets and liabilities of a distributor in Australia. The acquisition was
accounted for as a purchase. Accordingly, the operating results are included
in the Statements of Consolidated Earnings from the acquisition date. The
acquired assets and liabilities have been recorded at their estimated fair
values at the date of acquisition. The consideration was comprised of (i) $638
in cash, of which $479 was paid at closing, and (ii) 206 shares of the common
stock of the Company with a fair value of $1,796. In addition, the Company
assumed $1,417 of liabilities. The total cost of the acquisition was $3,851,
of which $1,244 was allocated to identified net tangible assets, primarily
accounts receivable. The remaining $2,607 represents the excess of the
purchase price over the fair value of the net assets acquired, which will be
amortized on a straight-line basis over three years. The operating results of
the distributor are insignificant to those of the Company.
7. Revenue Recognition
The Company adopted Statement of Position ("SOP") 97-2, "Software
Revenue Recognition", effective for transactions entered into commencing
September 1, 1998. SOP 97-2 indicates that revenue for noncustomized software
should be recognized when persuasive evidence of an arrangement exists, the
software has been delivered, the Company's selling price is fixed or
determinable and collectibility of the resulting receivable is probable. The
implementation of SOP 97-2 did not have a significant impact on the Company's
results of operations.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following is intended to update the information contained in the
Company's Annual Report on Form 10-K for the year ended August 31, 1998 and
presumes that readers have access to, and will have read, the "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
contained in such Form 10-K.
This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933
and Section 21E of the Securities Exchange Act of 1934. When used in this
report, the words "believe," "anticipate," "think," "intend," "plan," "will
be" and similar expressions identify such forward-looking statements. Such
statements regarding future events and/or the future financial performance
of the Company are subject to certain risks and uncertainties, including
those discussed in "Factors Affecting Future Performance" below at pages 16
to 24, which could cause actual events or the actual future results of the
Company to differ materially from any forward-looking statement. In light of
the significant risks and uncertainties inherent in the forward-looking
statements included herein, the inclusion of such statements should not be
regarded as a representation by the Company or any other person that the
objectives and plans of the Company will be achieved.
Overview
Acclaim Entertainment, Inc. ("Acclaim"), together with its subsidiaries
(Acclaim and its subsidiaries are collectively referred to as the
"Company"), is a worldwide developer, publisher and mass marketer of
interactive entertainment software ("Software") for use with dedicated
interactive entertainment hardware platforms ("Entertainment Platforms") and
multimedia personal computer systems ("PC"s). The Company owns and operates
four Software development studios (the "Studios"), located in the United
States and the United Kingdom, and publishes and distributes its Software
directly in North America, the United Kingdom, Germany, France and
Australia. The Company's operating strategy is to develop and maintain a
core of key brands and franchises (e.g., Turok, NFL Quarterback Club and All
Star Baseball) to support the various Entertainment Platforms and PCs that
dominate the interactive entertainment market at a given time or which the
Company perceives as having the potential for achieving mass market
acceptance. The Company emphasizes sports simulation and arcade-style
Software for Entertainment Platforms, and fantasy/role-playing, real-time
simulation, adventure and sports simulation Software for PCs.
The Company also engages, to a lesser extent, in the distribution of
Software developed by third-party Software publishers ("Affiliated Labels")
and the development and publication of comic book magazines and strategy
guides relating to the Company's Software.
The Company believes the Software industry is driven by the size of the
installed base of Entertainment Platforms (such as those manufactured by
Nintendo Co., Ltd. (Japan) (Nintendo Co., Ltd. and its subsidiary, Nintendo
of America, Inc., are collectively referred to as "Nintendo"), Sony
Corporation (Sony Corporation and its affiliate, Sony Computer Entertainment
America, are collectively referred to as "Sony") and Sega Enterprises Ltd.
("Sega")) and PCs dedicated for home use. The industry is characterized by
rapid technological change, resulting in Entertainment Platform and related
Software product cycles.
No single Entertainment Platform or system has achieved long-term
dominance in the interactive entertainment market. Accordingly, the Company
must continually anticipate and adapt its Software to emerging Entertainment
Platforms. The rapid technological advances in game systems have
significantly changed the look and feel of Software as well as the Software
development process. According to Company estimates, the average development
cost for a title for Entertainment Platforms approximately three years ago
was approximately $300,000 to $400,000, while the average development cost
for a title for Entertainment Platforms and PCs is currently between $1
million and
9
<PAGE>
$2 million. Approximately 75% of the Company's gross revenues in the first
quarter of fiscal 1999 was derived from Software developed by the Studios. The
process of developing Software is extremely complex and is expected to become
more complex and expensive in the future as new platforms and technologies are
introduced. See "Factors Affecting Future Performance - Increased Product
Development Costs."
The Company's performance has historically been materially affected by
platform transitions and product cycles. As a result of the industry
transition to 32- and 64-bit Entertainment Platforms which commenced in
1995, the Company's Software sales during fiscal 1996, 1997 and 1998 were
significantly lower than in fiscal 1994 and 1995. The Company's inability to
predict accurately the timing of such transition resulted in material losses
in fiscal 1996 and 1997. See "Factors Affecting Future Performance -
Industry Trends; Platform Transition; Technological Change."
The Company recorded net earnings of $8.0 million and $10.3 million in
the first quarter of fiscal 1998 and 1999, respectively. The fiscal 1999
period results primarily reflect increased sales in the United States of the
Company's 32- and 64-bit Software. Although revenues from the sale of N64
and PlayStation Software are anticipated to continue to grow in the second
quarter of fiscal 1999 and for fiscal 1999 as a whole, the Company does not
anticipate that, for fiscal 1999 as a whole, it will achieve its fiscal 1998
growth rate. No assurance can be given as to the future growth of the
installed base of 32- and 64-bit Entertainment Platforms, the future growth
of the Software market therefor or of the Company's results of operations
and profitability in future periods. The results for the first quarter of
fiscal 1998 and 1999 also reflect the Company's significantly reduced
operating expenses as compared to prior periods.
The Company's ability to generate sales growth and profitability will be
materially dependent on (i) the growth of the Software market for 32- and
64-bit Entertainment Platforms and PCs and (ii) the Company's ability to
identify, develop and publish "hit" Software for Entertainment Platforms
with significant installed bases.
Results of Operations
The following table sets forth certain statements of consolidated
operations data as a percentage of net revenues for the periods indicated:
Three Months Ended November 30,
-------------------------------
1998 1997
---- ----
Domestic revenues 70.3% 59.0%
Foreign revenues 29.7 41.0
---- ----
Net revenues 100.0 100.0
Cost of revenues 48.2 47.7
---- ----
Gross profit 51.8 52.3
Marketing and sales 16.7 18.5
General and administrative 14.3 15.3
Research and development 10.7 9.0
---- ---
Total operating expenses 41.7 42.8
Earnings from operations 10.1 9.5
Other income (expense), net 0.2 (0.7)
Earnings before income taxes 10.3 8.8
Net earnings 9.8 8.7
10
<PAGE>
Net Revenues
The Company's gross revenues were derived from the following product
categories:
Three Months Ended November 30,
-------------------------------
1998* 1997*
----- -----
Portable Software 2.0% 1.0%
16-bit Software --- 1.0%
32-bit Software 31.0% 15.0%
64-bit Software 60.0% 73.0%
PC Software 5.0% 9.0%
Other 2.0% 1.0%
*The numbers in this chart do not give effect to sales credits and
allowances granted by the Company in the periods covered since the Company
does not track such credits and allowances by product category. Accordingly,
the numbers presented may vary materially from those that would be disclosed
if the Company were able to present such information as a percentage of net
revenues.
The increase in the Company's net revenues from $92.3 million for the
quarter ended November 30, 1997 to $104.8 million for the quarter ended
November 30, 1998 was predominantly due to increased sales in the United
States of the Company's 32- and 64-bit Software. The increase in sales in
the fiscal 1999 quarter was primarily due to the continued increase in the
installed base of Nintendo's 64-bit N64 ("N64") and Sony's 32-bit
PlayStation ("PlayStation") consoles worldwide and the quality and market
acceptance of the Company's titles for those Entertainment Platforms.
Although revenues from the sale of N64 and PlayStation Software are
anticipated to continue to grow in the second quarter of fiscal 1999 and for
fiscal 1999 as a whole, the Company does not anticipate that, for fiscal
1999 as a whole, it will achieve its fiscal 1998 growth rate.
The Company's domestic sales in the first quarter of fiscal 1999
comprised a higher percentage of total net revenues as compared to the first
quarter of fiscal 1998 primarily because the titles published by the Company
in the 1999 period were aimed at, and achieved greater popularity in, the
domestic market (e.g., WWF War Zone and NFL Quarterback Club '99). The
Company anticipates that its mix of domestic and foreign net revenues will
continue to be affected by the content of titles released by the Company.
To date, the Company has not generated material revenues from any of its
operations other than Software publishing and no assurance can be given that
the Company will be able to generate such revenues in the future.
A significant portion of the Company's revenues in any quarter are
generally derived from Software first released in that quarter or in the
immediately preceding quarter. See "Factors Affecting Future Performance-
Revenue and Earnings Fluctuations; Seasonality" and "- Reliance on New
Titles; Product Delays."
In the quarter ended November 30, 1998, WWF War Zone (for multiple
platforms), NFL Quarterback Club '99 (for the N64), and Extreme G2 (for the
N64) accounted for approximately 31%, 23% and 15%, respectively, of the
Company's gross revenues. In the quarter ended November 30, 1997, Extreme G,
NFL Quarterback Club '98 and Turok: Dinosaur Hunter (all for the N64)
accounted for approximately 32%, 31% and 8%, respectively, of the Company's
gross revenues. See "Factors Affecting Future Performance - Reliance on
"Hit" Titles."
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The Company is substantially dependent on the Entertainment Platform
manufacturers as the sole manufacturers of the Entertainment Platforms
marketed by them, as the sole licensors of the proprietary information and
technology needed to develop Software for those Entertainment Platforms and,
in the case of Nintendo and Sony, as the sole manufacturers of Software for
the Entertainment Platforms marketed by them. For the quarters ended
November 30, 1997 and 1998, the Company derived 75% and 62% of its gross
revenues, respectively, from sales of Nintendo-compatible Software and 15%
and 31% of its gross revenues, respectively, from sales of Software for
PlayStation. In prior periods, the Company has also derived substantial
portions of its gross revenues from sales of Software for platforms marketed
by Sega. Such revenues have not been material in recent periods. Although
the Company does not plan to release any titles for Sega's 32-bit platform
in fiscal 1999, it may release titles for other Entertainment Platforms
introduced by Sega in future periods. See "Factors Affecting Future
Performance - Dependence on Entertainment Platform Manufacturers; Need for
License Renewals."
Gross Profit
Gross profit fluctuates primarily as a result of five factors: (i) the
level of returns, sales credits and allowances; (ii) the number of "hit"
products and average unit selling prices; (iii) the percentage of sales of
CD Software; (iv) the percentage of foreign sales; and (v) the percentage of
foreign sales to third-party distributors. All royalties payable to
Nintendo, Sony and Sega are included in cost of revenues.
The Company's gross profit is adversely impacted by increases in the
level of returns and allowances to retailers, which reduces the average unit
price obtained for its Software sales. Similarly, lack of "hit" titles or a
low number of "hit" titles, resulting in lower average unit sales prices,
adversely impacts the Company's gross profits.
The Company's margins on sales of CD Software (currently, PlayStation and
PCs) are higher than those on cartridge Software (currently, N64) as a
result of significantly lower CD Software product costs.
The Company's margins on foreign Software sales are typically lower than
those on domestic sales due to higher prices charged by hardware licensors
for Software distributed by the Company outside North America. The Company's
margins on foreign Software sales to third-party distributors are
approximately one-third lower than those on sales that the Company makes
directly to foreign retailers.
Gross profit increased from $48.3 million (52% of net revenues) for the
quarter ended November 30, 1997 to $54.3 million (52% of net revenues) for
the quarter ended November 30, 1998 predominantly due to increased sales
volume.
Management anticipates that the Company's future gross profit will be
affected principally by (i) the percentage of returns, sales credits and
allowances and other similar concessions in respect of the Company's
Software sales and (ii) the Company's product mix (i.e., the percentage of
CD Software). Although gross margins on sales of CD Software are higher than
on cartridge Software, management believes that if the Company is required
to institute stock-balancing programs for its PC Software, the Company will
experience higher rates of returns of such product as compared to the
historical rate of return of cartridge Software. In such event, management
anticipates that its reserves for such returns will increase, thereby
offsetting a portion of the higher gross margins generated from PC Software
sales.
The Company purchases substantially all of its products at prices payable
in United States dollars. Appreciation of the yen could result in increased
prices charged by Nintendo, Sony or Sega to the Company (although, to date,
none of them has effected such a price increase), which the Company may not
be able to pass on to its customers and which could adversely affect its
results of operations.
Operating Expenses
In fiscal 1997, the Company effected a variety of cost reduction measures
to reduce its operating expenses. The Company realized the benefits of such
measures in the fourth quarter of fiscal 1997 and
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thereafter in the form of reduced operating expenses as compared to prior
periods. In addition, in fiscal 1998, the Company consolidated or eliminated
certain operations.
Marketing and sales expenses were $17.1 million (19% of net revenues) for
the quarter ended November 30, 1997 and $17.5 million (17% of net revenues)
for the quarter ended November 30, 1998. The percentage decrease is
primarily attributable to increased sales volume.
General and administrative expenses were $14.1 million (15% of net
revenues) for the quarter ended November 30, 1997 and $14.9 million (14% of
net revenues) for the quarter ended November 30, 1998. The percentage
decrease is primarily attributable to increased sales volume.
Research and development expenses increased from $8.3 million (9% of net
revenues) for the quarter ended November 30, 1997 to $11.2 million (11% of
net revenues) for the quarter ended November 30, 1998. The increase was
primarily attributable to increased personnel costs at the Studios. Due to
the Company's planned release of a higher number of titles and increasing
Software development costs, the Company anticipates that its future research
and development expenses will continue to increase as a percentage of net
revenues as compared to fiscal 1998. See "Factors Affecting Future
Performance - Increased Product Development Costs."
Although the Company anticipates that its aggregate operating expenses
will increase in dollars in fiscal 1999, it does not anticipate that such
expenses will increase materially as a percentage of net revenues. However,
no assurance can be given that the Company's operating expenses will not
increase as a percentage of net revenues or that the cost reduction measures
heretofore effected will not materially adversely affect the Company's
ability to develop and publish commercially viable titles, or that such
measures, whether alone or in conjunction with increased revenues, if any,
will be sufficient to generate operating profits in fiscal 1999 and beyond.
See "Factors Affecting Future Performance - Recent Operating Results."
As of August 31, 1998, the Company had a U.S. tax net operating loss
carryforward of approximately $110 million. In the first quarter of fiscal
1998 and 1999, the Company utilized a portion of its net operating loss
carryforwards. The provision for income taxes of $0.5 million in fiscal 1999
primarily relates to state and foreign taxes.
Seasonality
The Company's business is seasonal, with higher revenues and operating
income typically occurring during its first, second and fourth fiscal
quarters (which correspond to the holiday selling season). However, the
timing of the delivery of Software titles and the releases of new products
cause material fluctuations in the Company's quarterly revenues and
earnings, which may cause the Company's results to vary from the seasonal
patterns of the industry as a whole. See "Factors Affecting Future
Performance-Revenue and Earnings Fluctuations."
Liquidity and Capital Resources
The Company derived net cash from operating activities of approximately
$7.1 million and $11.4 million during the quarter ended November 30, 1997
and 1998, respectively. The increase in net cash from operating activities
in the first quarter of fiscal 1999 is primarily attributable to profitable
operations.
The Company used net cash in investing activities of approximately $0.7
million and $2.2 million during the quarter ended November 30, 1997 and
1998, respectively. The increase in net cash used in investing activities in
the first quarter of fiscal 1999 is primarily attributable to the
acquisition of fixed assets and of certain assets of a distributor located
in Australia.
The Company used net cash in financing activities of approximately $1.1
million during the quarter ended November 30, 1997 and derived net cash from
financing activities of approximately $2.1 million during the quarter ended
November 30,1998. The increase in net cash provided by financing activities
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in the first quarter of fiscal 1999 as compared to the first quarter of
fiscal 1998 is primarily attributable to the proceeds of $2.7 million from
the exercise of outstanding stock options and warrants, and lower required
payments in respect of outstanding debt obligations during the 1999 period.
The Company generally purchases its inventory of Nintendo Software by
opening letters of credit when placing the purchase order. At November 30,
1998, the amount outstanding under letters of credit was approximately $39.1
million. Other than such letters of credit, the Company does not currently
have any material operating or capital expenditure commitments.
The Company has a revolving credit and security agreement with BNY, its
principal domestic bank, which agreement expires on January 31, 2000. The
credit agreement may be automatically renewed for another year by its terms,
unless terminated upon 90 days' prior notice by either party. The Company
draws down working capital advances and opens letters of credit against the
facility in amounts determined on a formula based on factored receivables
and inventory, which advances are secured by the Company's assets. BNY also
acts as the Company's factor for the majority of its North American
receivables, which are assigned on a pre-approved basis. At November 30,
1998, the factoring charge was 0.25% of the receivables assigned and the
interest on advances was at BNY's prime rate plus one percent. See Note 2 of
Notes to Consolidated Financial Statements and "Factors Affecting Future
Performance -- Liquidity and Bank Relationships."
The Company also has a financing arrangement relating to the mortgage on
its corporate headquarters. At November 30, 1998, the outstanding principal
balance of the loan was $2.5 million. See "Factors Affecting Future
Performance -- Liquidity and Bank Relationships."
Management believes, based on the currently anticipated growth of the
installed base of 32- and 64-bit Entertainment Platforms and the cost
reduction measures effected by the Company, that the Company's cash and cash
equivalents at November 30, 1998 and cash flows from operations in fiscal
1999 will be sufficient to cover its operating expenses and such current
obligations as are required to be paid in fiscal 1999. However, no assurance
can be given as to the sufficiency of such cash flows in fiscal 1999 and
beyond. To provide for its short- and long-term liquidity needs, in fiscal
1997 and 1998, the Company significantly reduced the number of its
employees, consolidated or eliminated certain operations, raised $47.4
million of net proceeds from the issuance of 10% Convertible Subordinated
Notes due 2002 (the "Notes"), and sold substantially all of the assets of
Acclaim Redemption Games, Inc., formerly Lazer-Tron Corporation
("Lazer-Tron"). The Company's future liquidity will be materially dependent
on its ability to develop and market Software that achieves widespread
market acceptance for use with the Entertainment Platforms that dominate the
market. There can be no assurance that the Company will be able to publish
Software for Entertainment Platforms with significant installed bases or
that such Software will achieve widespread market acceptance.
In conjunction with then pending class action and other litigations and
claims for which the settlement obligation was then probable and estimable,
the Company recorded a charge of $23.6 million during the year ended August
31, 1997. During fiscal 1998, the Company settled substantially all such
litigations and claims for amounts approximating the accrued liabilities.
The Company is also party to various litigations arising in the course of
its business, the resolution of none of which, the Company believes, will
have a material adverse effect on the Company's liquidity, financial
condition and results of operations.
Year 2000 Issue
Until recently, computer programs were generally written using two digits
rather than four to define the applicable year. Accordingly, such programs
may be unable to distinguish properly between the year 1900 and the year
2000. In fiscal 1997, the Company commenced a Year 2000 date conversion
project to address necessary code changes, testing and implementation in
respect of its internal computer systems. Project completion is planned for
the middle of calendar 1999. To date, the cost of this project has not been
material to the Company's results of operations or liquidity and the Company
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does not anticipate that the cost of completing the project will be material
to its results of operations or liquidity in fiscal 1999. Management
anticipates that the Company's Year 2000 date conversion project as it
relates to the Company's internal systems will be completed on a timely
basis. The Company's Software for N64, PlayStation and PCs are Year 2000
compliant. The Company is currently seeking information regarding Year 2000
compliance from vendors, customers, manufacturers, outside developers, and
financial institutions associated with the Company. Project completion for
this phase is planned for the middle of calendar 1999. However, given the
reliance on third-party information as it relates to their compliance
programs and the difficulty of determining potential errors on the part of
external service suppliers, no assurance can be given that the Company's
information systems or operations will not be affected by mistakes, if any,
of third parties or third-party failures to complete the Year 2000 project
on a timely basis. There can be no assurance that the systems of other
companies on which the Company's systems rely will be timely converted or
that any such failure to convert by another company would not have a
material adverse effect on the Company's systems.
The cost of the Company's Year 2000 project and the date on which the
Company believes it will complete the necessary modifications are based on
the Company's estimates, which were derived utilizing numerous assumptions
of future events, including the continued availability of resources,
third-party modification plans and other factors. The Company presently
believes that the Year 2000 issue will not pose significant operational
problems for its internal information systems and products. However, if the
anticipated modifications and conversions are not completed on a timely
basis, or if the systems of other companies on which the Company's systems
and operations rely are not converted on a timely basis, the Year 2000 issue
could have a material adverse effect on the Company's results of operations.
The Company does not currently have any contingency plans in place to
address the failure of timely conversion of its and/or third-party systems
in respect of the Year 2000 issue. Any failure of the Company to address any
unforeseen Year 2000 issues could materially adversely affect the Company's
results of operations.
Euro Conversion
The January 1, 1999 adoption of the Euro has created a single-currency
market in much of Europe. For a transition period from January 1, 1999 to
June 30, 2002, the existing local currencies will remain legal tender as
denominations of the Euro. The Company does not anticipate that its systems
will be materially adversely affected by the conversion to the Euro. The
Company has analyzed the impact of conversion to the Euro on its existing
systems and is implementing modifications to its current systems to handle
Euro invoicing for transactions. The Company anticipates that the cost of
such modifications will not have a material adverse effect on its results of
operations or liquidity in fiscal 1999. Due to numerous uncertainties, the
Company cannot reasonably estimate the effect that the conversion to the
Euro will have on its pricing or market strategies, and the impact, if any,
that such conversion will have on its financial condition or results of
operations.
New Accounting Pronouncement
The Company will implement the provisions of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" in fiscal 2000. The Company is presently assessing the impact,
if any, of this standard on its consolidated financial statements.
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FACTORS AFFECTING FUTURE PERFORMANCE
Future operating results of the Company depend upon many factors and are
subject to various risks and uncertainties. Some of the risks and
uncertainties which may cause the Company's operating results to vary from
anticipated results or which may materially and adversely affect its
operating results are as follows:
Recent Operating Results
The Company's net revenues increased from $92.3 million for the quarter
ended November 30, 1997 to $104.8 million for the quarter ended November 30,
1998. The Company had net earnings of $8.0 million and $10.3 million in the
quarter ended November 30, 1997 and 1998, respectively. For the most part, the
increase in revenues and earnings in the fiscal 1999 period reflects increased
sales in the United States of the Company's Software for the N64 and
PlayStation platforms. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
The Company's revenues and operating results in fiscal 1996 and 1997 were
affected principally by the industry transition from 16-bit to 32- and 64-bit
Entertainment Platforms. The Company had anticipated that sales of Software
for the older platforms would dominate Christmas 1995 sales and would be
material in Christmas 1996. Therefore, the Company focused its development
efforts on 16-bit Software for fiscal 1996 and 1997. However, sales of 16-bit
Software decreased much more rapidly than anticipated by the Company in
calendar 1996, which resulted in the Company's reduced revenues and net losses
in fiscal 1996 and 1997.
In 1998, the interactive entertainment hardware market was characterized
by the growth of the installed base of N64 and PlayStation units worldwide.
This growth had a positive impact on the Company's operating results for
fiscal 1998 and in the first quarter of fiscal 1999. Although N64 and
PlayStation have achieved significant market acceptance worldwide and the
Company anticipates that the installed base of N64 and PlayStation units will
continue to grow in the short term, the Company cannot assure investors that
the installed base of either or both will grow at the present rate, if at all.
Also, there is no assurance that the Company's revenues from sales of Software
for these platforms will increase as the installed base increases.
In fiscal 1997 and 1998, the Company took various actions to reduce its
operating expenses. See "--Liquidity and Bank Relationships" below for a
description of these actions. As a result, the Company's operating expenses in
the first quarter of fiscal 1998 and 1999 were substantially lower than in
prior comparable periods. Although the Company anticipates that its operating
expenses will increase in dollar terms in the remainder of fiscal 1999, the
Company intends to monitor its operating expenses closely and does not
anticipate that they will increase materially as a percentage of net revenues.
However, the Company cannot assure stockholders that its operating expenses
will not increase as a percentage of net revenues in the remainder of fiscal
1999 and beyond. Any such increase could negatively impact the Company's
profits in fiscal 1999 and beyond.
Liquidity and Bank Relationships
The Company generally experienced negative cash flow from operations in
fiscal 1996 and 1997 which, for the most part, was a result of the Company's
net losses in these periods.
The Company derived net cash from operations of approximately $7.1
million and $11.4 million in the first quarter of fiscal 1998 and 1999,
respectively. The Company believes that its cash flows from operations in
fiscal 1999 will be sufficient to cover its operating expenses and those
current obligations that it must pay in the remainder of fiscal 1999. The
Company's belief is based on the anticipated continued growth of the installed
base of 32- and 64- bit Entertainment Platforms, the anticipated success of
the Company's Software for those platforms and the resulting continued growth
of the Company's net revenues. However, the Company cannot assure investors
that its operating expenses and current obligations will be significantly less
than cash flows available from its operations in fiscal 1999 or in the
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future. The Company's long-term liquidity depends mainly on the Company
publishing "hit" Software for the dominant Entertainment Platforms.
In order to provide liquidity, in fiscal 1997 and 1998, the Company took
a number of actions including: (1) significantly reducing the number of its
employees, (2) consolidating its Studio operations and (3) eliminating certain
operations, such as its coin-operated video game subsidiary. In addition, in
February 1997, the Company completed an offering of $50 million of Notes. Of
the net proceeds of the offering, the Company used approximately $16 million
to retire a term loan from Midland Bank plc ("Midland") and $2 million to pay
down a portion of a mortgage loan from Fleet Bank ("Fleet"). In March 1997,
the Company sold substantially all of the assets and certain liabilities of
Lazer-Tron for $6 million in cash.
Under its revolving credit facility with BNY Financial Corporation
("BNY"), its lead institutional lender, the Company is required to comply with
certain financial covenants which are generally measured on a quarterly basis.
The Company was in compliance with such covenants as of November 30, 1998.
Although the Company expects to continue to comply with such covenants, it
cannot make any guarantee of compliance. In addition, factors beyond the
Company's control may result in future covenant defaults or a payment default.
The Company may not be able to obtain waivers of any future default(s). If
such defaults occur and are not waived by the lender, the lender could
accelerate the loan or exercise other remedies. Such actions would have a
negative impact on the Company's liquidity and operations.
Substantial Leverage and Ability to Service Debt
The Company's debt level could have important consequences to its
stockholders because a portion of cash flow from operations must be set aside
to pay down debt, including the outstanding Notes, and its existing bank
obligations. Therefore, these funds are not available for other purposes.
Additionally, a high debt level limits the Company's ability to obtain
additional debt financing in the future, or to pursue possible expansion of
its business or acquisitions. Also, high debt levels could limit the Company's
flexibility in reacting to changes in the interactive entertainment industry
and economic conditions generally. These limitations make the Company more
vulnerable to adverse economic conditions and restrict its ability to
withstand competitive pressures or take advantage of business opportunities.
Some of the Company's competitors currently have a lower debt level, and are
likely to have significantly greater operating and financing flexibility, than
the Company.
Based upon current levels of operations, the Company believes it can meet
its interest obligations on the Notes, and interest and principal obligations
under its bank agreements, when due. However, if the Company's cash flow from
operations is not enough to meet its debt obligations when due, the Company
may have to restructure its indebtedness. The Company cannot guarantee that it
will be able to restructure or refinance its debt on satisfactory terms. In
addition, restructuring or refinancing may not be permitted by the terms of
the indenture governing the Notes (the "Indenture"), or existing indebtedness.
The Company cannot assure stockholders that its operating cash flows will be
sufficient to meet debt service requirements. Also, the Company cannot
guarantee stockholders that its future operating cash flows will be sufficient
to repay the Notes, or that the Company will be able to refinance the Notes or
other indebtedness at maturity. See "--Prior Rights of Creditors".
Prior Rights of Creditors
The Company has outstanding long-term debt (including current portions)
of $52.2 million at November 30, 1998. Certain of the indebtedness is secured
by liens on substantially all of the Company's assets. If the Company does not
timely pay interest or principal on its indebtedness when due, the Company
will be in default under its loan agreements and the Indenture.
In addition, the Indenture provides that, upon the occurrence of certain
events, the Company may be obligated to repurchase all or a portion of the
outstanding Notes. If such a repurchase event occurs and the Company does not
have, or is unable to obtain, sufficient financial resources to repurchase the
Notes, the Company would be in default under the Indenture. In addition, the
occurrence of certain repurchase events would constitute a default under some
of the Company's current loan agreements.
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Further, the Company depends on dividends and other advances and
transfers of funds from its subsidiaries to meet some debt service
obligations. State and foreign law regulate the payment of dividends by the
Company's subsidiaries, which is also subject to the terms of the Company's
existing bank agreements and the Indenture. A significant portion of the
Company's assets, operations, trade payables and other indebtedness is located
at its subsidiaries. The creditors of the subsidiaries would generally recover
from these assets on the obligations owed to them by the subsidiaries before
any recovery by the Company's creditors and before any assets are distributed
to the Company's stockholders.
If the Company is unable to meet its current bank obligations, a default
would occur under the Company's existing bank agreements. Such default, if not
waived, could result in acceleration of the Company's obligations under the
bank agreements. Moreover, default could result in a demand by the lenders for
immediate repayment and would entitle any secured creditor in respect of such
debt to proceed against the collateral securing the defaulted loan.
Additionally, an event of default under the Indenture may result in actions by
IBJ Schroder Bank & Trust Company, as trustee, on behalf of the holders of the
Notes. In the event of such acceleration by the Company's creditors or action
by the trustee, holders of indebtedness would be entitled to payment out of
the Company's assets. If the Company becomes insolvent, is liquidated or
reorganized, it is possible that there would be insufficient assets remaining
after payment to the creditors for any distribution to the Company's
stockholders.
Industry Trends; Platform Transition; Technological Change
The interactive entertainment industry is characterized by rapid
technological change due in large part to:
o the introduction of Entertainment Platforms incorporating more advanced
processors and operating systems;
o the impact of technological changes embodied in PCs;
o the development of electronic and wireless delivery systems; and
o the entry and participation of new companies in the industry.
These factors, among others, have resulted in Entertainment Platform and
Software life cycles.
No single Entertainment Platform has achieved long-term dominance.
Accordingly, the Company must continually anticipate and adapt its Software to
emerging Entertainment Platforms and systems. The process of developing
Software is extremely complex and is expected to become more complex and
expensive in the future as new platforms and technologies are introduced.
Development of Software currently requires substantial investment in
research and development in the areas of graphics, sound, digitized speech,
music and video. The Company cannot guarantee that it will be successful in
developing and marketing Software for new Entertainment Platforms.
Substantially all of the Company's revenues in the first quarter of
fiscal 1998 and 1999 were derived from the sale of Software designed for N64,
PlayStation and PCs. In the past, the Company has expended significant
development and marketing resources on product development for Entertainment
Platforms that have not achieved the results it anticipated. If the Company
(1) does not develop Software for Entertainment Platforms that achieve
significant market acceptance, (2) discontinues development of Software for a
platform that has a longer than expected life cycle, (3) develops Software for
a platform that does not achieve a significant installed base or (4) continues
development of Software for a platform that has a shorter than expected life
cycle, the Company may experience losses from operations. The Company cannot
guarantee that it will be able to predict accurately such matters, and failure
to do so would negatively affect the Company.
The Company's results of operations and cash flows were negatively
affected during fiscal 1996 and 1997 by the significant decline in sales of
the Company's 16-bit Software and the transition to the new
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Entertainment Platforms. Because (1) there were a significant number of titles
competing for limited shelf space and (2) the new Entertainment Platforms had
not achieved market penetration similar to that of the 16-bit platforms in
prior years, the number of units of each title sold for the newer
Entertainment Platforms was significantly less than the number of units of a
title generally sold in prior years for 16-bit platforms. In 1998, the
interactive entertainment hardware market was characterized by the worldwide
growth of the installed base of N64 and PlayStation units and related
Software. Although the Company anticipates that the installed base of these
platforms will continue to grow in the short term and that the market for
Software for these platforms will also continue to grow, the Company cannot
guarantee that the hardware or Software market will continue to grow at the
current rate.
Revenue and Earnings Fluctuations; Seasonality
Historically, the Company has derived substantially all of its revenues
from the publication and distribution of Software for the then dominant
Entertainment Platforms. The Company's revenues are subject to fluctuation
during transition periods, as in fiscal 1996 and 1997, when new Entertainment
Platforms have been introduced but none has achieved mass-market penetration.
In addition, the timing of release of the Company's new titles impacts the
Company's earnings in any given period. Earnings also may be materially
impacted by other factors including: (1) the level and timing of market
acceptance of titles, (2) increases or decreases in development and/or
promotion expenses for new titles and (3) the timing of orders from major
customers.
A significant portion of the Company's revenues in any quarter is
generally derived from sales of new titles introduced in that quarter or in
the immediately preceding quarter. If the Company is unable to begin volume
shipments of a significant new title during the scheduled quarter, its
revenues and earnings will be negatively affected in that quarter. In
addition, because a majority of the unit sales for a title typically occur in
the first 90 to 120 days following the introduction of the title, the
Company's earnings may increase significantly in a period in which a major
title is introduced and may decline in the following period or in periods in
which there are no major title introductions. Also, certain operating expenses
are fixed and do not vary directly in relation to revenue. Consequently, if
net revenue is below expectations, the Company's operating results are likely
to be negatively affected.
The interactive entertainment industry is highly seasonal. Typically, net
revenues are highest during the last calendar quarter (which includes the
holiday selling season), decline in the first calendar quarter, are lower in
the second calendar quarter and increase in the third calendar quarter. The
seasonal pattern is due primarily to the increased demand for Software during
the year-end holiday selling season. However, the Company's earnings vary
significantly and are largely dependent on releases of major new titles and,
accordingly, may not necessarily reflect the seasonal patterns of the industry
as a whole. The Company expects that its operating results will continue to
fluctuate significantly in the future.
Dependence on Entertainment Platform Manufacturers; Need for License Renewals
The following table shows the percent of the Company's gross revenues for
the first quarter of fiscal 1998 and 1999 derived from sales of Software for
the indicated platforms:
Quarter Ended November 30,
Title 1997 1998
----- ---- ----
Nintendo- compatible 75% 62%
Sony-compatible 15% 31%
The Company is substantially dependent on the Entertainment Platform
manufacturers as the sole manufacturers of the Entertainment Platforms
marketed by them, as the sole licensors of the proprietary information and
technology needed to develop Software for those Entertainment Platforms and,
in the case of Nintendo and Sony, as the sole manufacturers of the Software
developed by the Company for the compatible Entertainment Platform. The
Entertainment Platform manufacturers have in the past and may in the future
limit the number of titles the Company can release in any year, which may
limit any future growth in sales.
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In the past, the Company has been able to renew and/or negotiate
extensions of its Software license agreements with the Entertainment Platform
developers. However, the Company cannot assure stockholders that, at the end
of their current terms, the Company will be able to obtain extensions or that
it will be successful in negotiating definitive license agreements with
developers of new Entertainment Platforms.
If the Company cannot obtain licenses from developers of new
Entertainment Platforms or if its existing license agreements are terminated,
the Company's financial position and results of operations will be materially
adversely affected. In addition, the termination of any one of the Company's
license agreements or other arrangements could negatively affect its financial
position and results of operations.
In addition to licensing arrangements, the Company depends on the
Entertainment Platform manufacturers for the protection of the intellectual
property rights to their respective Entertainment Platforms and technology and
their ability to discourage unauthorized persons from producing software for
the Entertainment Platforms developed by each of them. The Company also relies
upon the Entertainment Platform manufacturers for the manufacture of certain
cartridge and CD-based read-only memory (ROM) software.
Reliance on New Titles; Product Delays
The Company's ability to maintain favorable relations with retailers and
to receive the maximum advantage from its advertising expenditures depends on
its ability to provide retailers with a timely and continuous flow of product.
The life cycle of a title generally ranges from less than three months to
upwards of 12 months, with the majority of sales occurring in the first 90 to
120 days after release. The Company actively markets its current releases
while simultaneously supporting its back catalogue with pricing and sales
incentives. The Company is constantly required to develop, introduce and sell
new titles in order to generate revenue and/or to replace declining revenues
from previously released titles. In addition, it is difficult to predict
consumer preferences for titles, and few titles achieve sustained market
acceptance. The Company cannot assure stockholders that its new titles will be
released in a timely fashion, will achieve any significant degree of market
acceptance, or that such acceptance will be sustained for any meaningful
period. Competition for retail shelf space, consumer preferences and other
factors could result in the shortening of the life cycle for older titles and
increase the importance of the Company's ability to release titles on a timely
basis.
The timely shipment of a title depends on various factors, including
quality assurance testing by the Company and the manufacturers. The Company
generally submits new titles to the Entertainment Platform manufacturers and
other intellectual property licensors for approval prior to development and/or
manufacture. Since the Company is required to engage Nintendo or Sony, as the
case may be, to manufacture titles developed by the Company for the platforms
marketed by them, the Company's ability to control its supply of Nintendo or
Sony titles and the timing of their delivery is limited.
If the title is rejected by the manufacturer as a result of bugs in
Software or if there is a substantial delay in the approval of a product by an
Entertainment Platform manufacturer or licensor, the Company's financial
condition and results of operations could be negatively impacted. In the past,
the Company has experienced significant delays in the introduction of certain
new titles and such delays may occur in the future. Moreover, it is likely
that in the future certain new titles will not be released in accordance with
the Company's internal development schedule or the expectations of public
market analysts and investors. A significant delay in the introduction of, or
the presence of a defect in, one or more new titles could negatively affect
the ultimate success of the Company's titles. If the Company does not develop,
introduce and sell new competitive titles on a timely basis, its results of
operations and profitability will be negatively affected.
Reliance on "Hit" Titles
The market for Software is "hits" driven. Therefore, the Company's future
success depends on developing and marketing "hit" titles for Entertainment
Platforms with significant installed bases. Sales of
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<PAGE>
the Company's top three titles accounted for approximately 69% of gross
revenues for the first quarter of fiscal 1999 and sales of the Company's top
three titles accounted for approximately 71% of gross revenues for the first
quarter of fiscal 1998. The Company cannot assure stockholders that it will be
able to publish "hit" titles in the future. If the Company does not publish
"hit" titles in the future, its financial condition, results of operations and
profitability could be negatively affected, as they were in fiscal 1996 and
1997.
Inventory Management; Risk of Product Returns
Generally, the Company is not contractually obligated to accept returns,
except for defective product. However, the Company may permit customers to
return or exchange product and may provide price protection or other
concessions on products unsold by the customer. Accordingly, management must
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements. Also, management must make estimates and assumptions
that affect the reported amounts of revenues and expenses during the reporting
periods.
Among the more significant of such estimates are allowances for estimated
returns, price concessions and other discounts. At the time of shipment, the
Company establishes reserves in respect of such estimates taking into account
the potential for product returns and other discounts based on historical
return rates, seasonality, level of retail inventories, market acceptance of
products in retail inventories and other factors. In fiscal 1996, price
allowances, returns and exchanges were significantly higher than reserves.
This shortfall had a negative impact on the Company's results of operations
and liquidity in fiscal 1996. The Company believes that, at November 30, 1998,
it has established adequate reserves for future price protection, returns,
exchanges and other concessions. However, the Company cannot guarantee the
adequacy of its reserves. If the reserves are exceeded, the Company's
financial condition and results of operations will be negatively impacted.
In addition, the Company offers stock-balancing programs for its PC
Software. The Company has established reserves for such programs, which have
not been material to date. Future stock-balancing programs may become material
and/or exceed reserves for such programs. If so exceeded, the Company's
results of operations and financial condition could be negatively impacted.
Litigation
In conjunction with then pending class action and other litigations and
claims for which the settlement obligation was then probable and estimable,
the Company recorded a charge of $23.6 million during the year ended August
31, 1997. During fiscal 1998, the Company settled substantially all such
litigations and claims for amounts approximating the accrued liabilities.
The Company is also party to various litigations arising in the course of
its business and certain other litigations. For a discussion of certain claims
and litigations to which the Company is currently a party, see "Legal
Proceedings." The Company may be required to record additional material
charges in future periods in conjunction with litigations to which the Company
is or becomes a party. If the Company has to record additional charges to
earnings from an adverse result in such litigations or from settlements which
exceed the related accrued liabilities, the Company may experience a negative
effect on its financial condition and results of operations.
Increased Product Development Costs
As a result of the calendar 1995 acquisitions of its Studios, beginning
in fiscal 1996, the Company's fixed software development and overhead costs
were significantly higher as compared to historical levels. These costs
negatively impacted the Company's results of operations and profitability in
fiscal 1996 and 1997. In fiscal 1998, the Company consolidated its Studio
operations to reduce their overhead expenses. Due to the Company's planned
release of a higher number of titles and increasing Software development
costs, the Company anticipates that its future research and development
expenses will continue to
21
<PAGE>
increase as a percentage of net revenues as compared to fiscal 1998. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Results of Operations."
Competition
The market for Software is highly competitive. Only a small percentage
of titles introduced in the Software market achieve any degree of sustained
market acceptance. Competition is based primarily upon:
o quality of titles;
o the publisher's access to retail shelf space;
o product features;
o the success of the Entertainment Platform for which the Software is
written;
o price of titles;
o the number of titles available for the Entertainment Platform for
which the Software is written; and
o marketing support.
The Company competes with a variety of companies that offer products that
compete directly with one or more of its titles. Typically, the chief
competitor on an Entertainment Platform is the developer of that platform, to
whom the Company pays royalties and, in some cases, manufacturing charges.
Accordingly, the developers have a price, marketing and distribution advantage
with respect to Software marketed by them. This advantage is particularly
important in a mature or declining market which supports fewer full-priced
titles and is characterized by customers who make purchasing decisions on
titles based primarily on price, unlike developing markets with limited
titles, when price has been a less important factor in Software sales. The
Company's competitors vary in size from very small companies with limited
resources to very large corporations with greater financial, marketing and
product development resources than the Company, such as Nintendo, Sega and
Sony. The Company's competitors also include a number of independent Software
publishers licensed by the hardware developers.
Additionally, the entry and participation of new companies, including
diversified entertainment companies, in markets in which the Company competes
may adversely impact the Company's performance in these markets.
The availability of significant financial resources has become a major
competitive factor in the Software industry, primarily as a result of the
costs associated with developing and marketing Software. As competition
increases, significant price competition and reduced profit margins may
result. In addition, competition from new technologies may reduce demand in
markets in which we have traditionally competed. Prolonged price competition
or reduced demand as a result of competing technologies would negatively
impact the Company's business. The Company may not be able to compete
successfully.
Intellectual Property Licenses and Proprietary Rights
Some of the Company's Software embodies trademarks, tradenames, logos or
copyrights licensed to the Company by third parties (such as the NBA, the NFL
or their respective players' associations), the loss of which could prevent
the release of a title or limit its economic success. License agreements
generally extend for a term of two to three years and are terminable in the
event of material breach (including failure to pay amounts due by the Company
to the licensor in a timely manner) by, or bankruptcy or insolvency of, the
Company and certain other events. Since competition is intense, the Company
may not be successful in the future in acquiring intellectual property rights
with significant commercial value. In addition, the Company cannot assure its
stockholders that these licenses will be available on reasonable terms or at
all.
In order to protect its titles and proprietary rights, the Company relies
mainly on a combination of:
22
<PAGE>
o copyrights;
o trade secret laws;
o patent and trademark laws;
o nondisclosure agreements; and
o other copy protection methods.
It is Company policy that all employees and third-party developers sign
nondisclosure agreements. These measures may not be sufficient to protect the
Company's intellectual property rights against infringement. Additionally, the
Company has "shrinkwrap" license agreements with the end users of its PC
titles, but relies on the copyright laws to prevent unauthorized distribution
of its other Software.
Existing copyright laws afford only limited protection. Notwithstanding
the Company's rights to its Software, it may be possible for third parties to
copy illegally its titles or to reverse engineer or otherwise obtain and use
the Company's proprietary information. Illegal copying occurs within the
Software industry, and if a significant amount of illegal copying of the
Company's published titles or titles distributed by the Company occurs, the
Company's business could be adversely impacted. Policing illegal use of the
Company's titles is difficult, and Software piracy is expected to persist.
Further, the laws of certain countries in which the Company's titles are
distributed do not protect the Company and its intellectual property rights to
the same extent as the laws of the United States.
The Company believes that its titles, trademarks and other proprietary
rights do not infringe on the proprietary rights of others. However, as the
number of titles in the industry increases, the Company believes that claims
and lawsuits with respect to software infringement will also increase. From
time to time, third parties have asserted that features or content of certain
of the Company's titles may infringe upon intellectual property rights of such
parties. The Company has asserted that third parties have likewise infringed
its proprietary rights. Some of these claims have resulted in litigation by
and against the Company. To date, no such claims have had a negative effect on
the Company's ability to develop, market or sell its titles. Existing or
future infringement claims by or against the Company may result in costly
litigation or require the Company to license the intellectual property rights
of third parties.
The owners of intellectual property licensed by the Company generally
reserve the right to protect such intellectual property against infringement.
International Sales
International sales represented approximately 41% and 30% of net revenues
in the first quarter of 1998 and 1999, respectively. The Company expects that
international sales will continue to account for a significant portion of its
net revenues in future periods. International sales are subject to the
following inherent risks:
o unexpected changes in regulatory requirements;
o tariffs and other economic barriers;
o fluctuating exchange rates;
o difficulties in staffing and managing foreign operations; and
o the possibility of difficulty in accounts receivable collection.
Because the Company believes that exposure to foreign currency losses is
not currently material, the Company does not hedge against foreign currency
risks.
In some markets, localization of the Company's titles is essential to
achieve market penetration. As a result of the inherent risks, the Company may
incur incremental costs and experience delays in localizing the Company's
titles. These risk factors or other factors could have a negative effect on
the Company's future international sales and, consequently, on its business.
23
<PAGE>
Dependence on Key Personnel and Employees
The Software industry is characterized by a high level of employee mobility
and aggressive recruiting among competitors for personnel with technical,
marketing, sales, product development and management skills. The Company's
successful operations depend on the Company's ability to identify, hire and
retain such personnel. The Company may not be able to attract and retain such
personnel or may incur significant costs in order to do so.
In particular, the Company is highly dependent upon the management
services of Gregory Fischbach, Co-Chairman of the Board and Chief Executive
Officer, and James Scoroposki, Co-Chairman of the Board and Senior Executive
Vice President. The loss of the services of either of these two could have a
negative impact on the Company's business. Although the Company has employment
agreements with Messrs. Fischbach and Scoroposki, they may leave or compete
with the Company in the future. If the Company is unable to attract additional
qualified employees or retain the services of key personnel, the Company's
business could be negatively impacted.
Anti-Takeover Provisions
The Board of Directors has the authority (subject to certain limitations
imposed by the Indenture) to issue shares of preferred stock and to determine
their characteristics without stockholders approval. If preferred stock is
issued, the rights of holders of common stock, par value $0.02 per share (the
"Common Stock"), of the Company are subject to, and may be negatively affected
by, the rights of preferred stockholders. If preferred stock is issued, it
will provide flexibility in connection with possible acquisitions and other
corporate actions; however, it could make it more difficult for a third-party
to acquire a majority of the Company's outstanding voting stock. In addition,
the Company is subject to the anti-takeover provisions of Section 203 of the
Delaware General Corporation Law, which may make it more difficult or more
expensive or discourage a tender offer, change in control or takeover attempt
that is opposed by the Board. In addition, employment arrangements with
certain members of the Company's management provide for severance payments
upon termination of their employment if there is a change in control.
Volatility of Stock Price
There is a history of significant volatility in the market prices of
companies engaged in the software industry, including the Company. The market
price of the Common Stock is likely to continue to be highly volatile. The
following factors may have a significant impact on the market price of the
Common Stock:
o timing and market acceptance of product introductions by the Company;
o the introduction of products by the Company's competitors;
o loss of any of the Company's key personnel;
o variations in quarterly operating results; or
o changes in market conditions in the software industry generally.
In the past, the Company has experienced significant fluctuations in its
operating results and, if its future revenues or operating results or product
releases do not meet expectations, the price of the Common Stock may be
negatively affected.
Stockholders should not use historical trends as well as other factors
affecting the Company's operating results and financial condition to
anticipate results or trends in future periods because of the risk factors
disclosed above. Also, stockholders should not consider historic financial
performance as a reliable indicator of future performance.
24
<PAGE>
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company, Iguana and Gregory E. Fischbach were sued in an action
entitled Jeffery Spangenberg vs. Acclaim Entertainment, Inc., Iguana
Entertainment, Inc., and Gregory Fischbach filed in August 1998 in the
District Court of Travis County, Texas (Cause No. 98-09418). The plaintiff
alleges that the defendants (i) breached their employment obligations to the
plaintiff, (ii) breached a Texas statute covering wage payment obligations
based on their alleged failure to pay bonuses to the plaintiff; and (iii)
made fraudulent misrepresentations to the plaintiff in connection with the
plaintiff's employment relationship with the Company, and accordingly, seeks
unspecified damages. The Company intends to defend this action vigorously.
The Securities and Exchange Commission (the "Commission") has issued
orders directing a private investigation relating to, among other things,
the Company's earnings estimate for fiscal 1995 and its decision in the
second quarter of fiscal 1996 to exit the 16-bit portable and cartridge
markets. The Company has provided documents to the Commission, and the
Commission has taken testimony from Company representatives. The Company
intends fully to cooperate with the Commission in its investigation. No
assurance can be given as to whether such investigation will result in any
litigation or, if so, as to the outcome of this matter.
In conjunction with then pending class action and other litigations and
claims for which the settlement obligation was then probable and estimable,
the Company recorded a charge of $23.6 million during the year ended August
31, 1997. During fiscal 1998, the Company settled substantially all of its
outstanding litigations and claims for amounts approximating the accrued
liabilities.
The Company is also party to various litigations arising in the ordinary
course of its business, the resolution of none of which, the Company
believes, will have a material adverse effect on the Company's liquidity or
results of operations.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In November 1998, in connection with the Company's purchase of
substantially all of the assets and liabilities of Fringe Pty. Ltd., an
Australian distributor, the Company issued 206,000 shares of Common Stock to
Fringe Pty. Ltd. in partial payment of the purchase price. The shares were
issued pursuant to the exemption from registration provided under Section
4(2) of the Securities Act of 1933. See Note 6 of Notes to Consolidated
Financial Statements.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K
None.
25
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ACCLAIM ENTERTAINMENT, INC.
By: Gregory Fischbach January 13, 1999
-----------------------------
Gregory Fischbach
Co-Chairman of the Board;
Chief Executive Officer;
President; Director
By: James Scoroposki January 13, 1999
-----------------------------
James Scoroposki
Co-Chairman of the Board;
Executive Vice President;
Treasurer; Secretary;
Director; and Acting
Chief Financial and
Accounting Officer
26
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